ACH System Scores Crucial Victory

Financial institutions and advocates of a vibrant electronic payment system won a crucial early victory in a federal courthouse in New York last week. Specifically, a federal judge dismissed a lawsuit seeking to sue Bank of America for honoring ACH debit transactions to pay for payday loans. The court ruled that the bank did not violate its account agreement or engage in unfair or deceptive practices when it followed electronic clearinghouse rules.

Why is this ruling so important? Because the lawsuit is an outgrowth of an attempt by New York’s Department of Financial Services to brow-beat banks and credit unions into refusing to process payday loans. To understand the importance of this case, look at the number of ACH debit transactions your credit union will process today. Imagine if you could not rely on the representations made by the bank originating the transaction that the debits are legally authorized. Conversely, imagine if your member could hold you responsible for every ACH transaction, even if they have contractually agreed to let a merchant pull money from their account. My guess is that the ACH system would grind to a halt, and quickly.

In Costoso v. Bank of America (14-CV-4100), a plaintiff took six payday loans with out-of-state lenders. As is common with almost all payday loans, when she entered into these agreements, she agreed to authorize the payday lenders to request that payments be electronically debited from her account over the ACH network. The plaintiff argued that the bank violated its own account agreement and various New York laws by processing payments for loans that violated New York’s interest-rate cap on non-bank lenders of 16%. She pointed to language in the account agreement stipulating that the bank would strictly adhere to NACHA operating rules, which governs ACH transactions. These rules require financial institutions to block ACH transactions that it knows to be unlawful or unauthorized.

The court rejected this argument. In a crucial passage that all NACHA members should memorize, the court held that even if the defendants were obligated to comply with NACHA rules with respect to debits on consumer accounts, “defendants may rely on the representations of the original depository financial institutions, the bank that processes the ACH debit for the payday lender.” This sentence reaffirms one of the most important lynchpins of the ACH network.

I can already hear consumer groups bemoaning this decision. So, let’s be clear on what it does not do. It does not legalize payday loans in New York. Perhaps future plaintiffs should sue banks that knowingly hold accounts for out-of-state payday lenders who offer such loans in New York. In addition, the ruling means that credit unions and banks don’t have to hesitate before honoring a member’s request that payments to their health club, for example, be automatically debited from their account. This is good for consumers.